ECN 481 Lecture 5: Measuring Interest Rates and Returns

49 views3 pages

tealcattle598

6 Nov 2017

School

Department

Course

Professor

For unlimited access to Class Notes, a Class+ subscription is required.

Document Summary

Bond interest rate is more formally called its yield to maturity. Yield to maturity - the interest rate which equates the present value of all future payments with the current bond price. F = (p) + (i)(p) = (p)(1 + i) To obtain the present value of the future payment, solve for p. P = f/(1 + i) -- present value of payment (f) received one year from now. Consider formula (for simplicity, let a1 = a2 = a3 = = an = a) + a/(1 + i)3 + + a/(1 + i)n. Given any 2 variables, we can solve for the third. Example #1: given a and i, solve for p. Example -- you win ,000 for year 1, ,000 for year 2, and ,000 for year 3, with i = 0. 08. Series of future payments: coupon payment each year equal to c = (ic)(f), along with the face value (f) (or par value) at maturity.

Related Questions

I am having problems with this problem from my Econcoursework. Iunderstand how to do parts 1 and 2, but amhaving trouble with parts3 and 4. For part 3, how do I dothe calculation for an infiniteperiod? As the time becomeslonger the present value goes to zero,so do i assume a period, oris there an actual method for infiniteperiods? For part 4,do I simply do the sum for the future value andplug it into thePresent value equation? Not really looking for thesolutionhere, but I need some help getting the third and fourthpartssolved.

Congratulations! You just won the lottery! You can elect toreceiveyour prize in one of four
payment streams:
(i) $1,000,000 now
(ii) $1,500,000 at the end of five years
(iii) $60,000 per year in perpetuity (for ever), with paymentsmadeat the end of each year (so your
first payment comes one year from today)
(iv) $150,000 per year for the next ten years, with payments madeatthe end of each year (so your
first payment comes one year from today)

Suppose the annual interest rate is 5% with certainty andinperpetuity. Calculate the present value of
each of the four payment options (i.e., in todayâs dollars).Rankfor four options from most to least
valuable. You can use Excel or a calculator to solve this, butyoumust show the formulas you use.

1. You are in a carâ accident, and you receive an insurance settlement of $6500 per year for the next three years. The first payment is to be received today. The second payment is to be received one year fromâ today, and the third payment two years from today. If the interest rate is 3â%, the present value of the insurance settlement is ?

2. If a lender makes a simple loan of $700 for 4 years and charges 3â%, then the amount that the lender receive at maturity is ?

This assignment requires the following knowledge: For k different events, if the probability that each of them happens is p (0 < p < 1) and all events happen independently, the probability that all events happen together is p^k.
1. Five firms, namely A, B, C, D and E, issue discounted bonds with face value $1,000 and maturity 5 years in the market. All firms are pretty risky and each of them has a chance of 0.5 of collapse during the five years (thus bankrupted and can not pay back the bond accordingly). The bonds are all sold at an interest rate of 50% (the value is not surprising due to the extremely high risk of default).
(1) What is the present value of the bond given the interest rate, the face value and the maturity? Hint: we temporarily do not consider the issue of default.
(2) Say now you buy one bond from each of the five firms, what is the total amount you lend out today? Eventually only one firm does not fail and pays back the bond, what is the money you collect back 5 years later? You gain or loss in this case? If more than one firm pays back the bond, will you get more money back?
(3) What is the chance (probability) that you get nothing back assuming that firms fail independently? Together with the answer in (2), is it a good deal to buy one bond from each of the five firms?
(4) Repeat (2) and (3) with the only difference that now you buy 5 bonds from a single firm.
(5) Now we assume that the five firms all have similar businesses in Greece (and those are their only businesses), therefore, all firm fail together if the economy in Greece fails. Will you answer in (3) change?

ECN 481 Lecture 5: Measuring Interest Rates and Returns

Document Summary

Get access

Related Documents

EC223 Lecture Notes - Lecture 4: Zero-Coupon Bond, Cash Flow, Nominal Interest Rate

ECON 3430 Lecture Notes - Lecture 4: Nominal Interest Rate, Zero-Coupon Bond, Uses Of English Verb Forms

EC223 Lecture Notes - Lecture 4: Zero-Coupon Bond, Hm Treasury, Cash Flow

Related Questions